Bank of England Preview: Will the BoE match the ECB’s dovish hike?

The Bank of England (BoE) is gearing up for its September meeting, with the monetary policy committee due to announce their latest monetary policy decision on Thursday 21st September. Despite a downward trajectory for inflation, there is a strong possibility of a 15th consecutive rate hike on Thursday. Should that come to fruition, it would see the Bank Rate rise to 5.5%, a level not seen since 2008. However, the context surrounding this hike has shifted, with the economy losing momentum and inflation gradually receding from its peak. As a result, this upcoming hike is increasingly likely to be the last one in the current tightening cycle, which poses downside risks for the pound.

Currently, the market assigns an approximately 80% probability to a 25-basis point rate hike at the September meeting, with a 20% chance of no change in rates.

Official Bank Rate

What does the economy look like?

Inflation remains the key concern for the BoE, with August’s CPI report is expected to show a temporary uptick from 6.8% to 7%. With core inflation set to fall, there is a clear feeling that factors such as energy are starting to play a role in re-inflating prices after a period of energy-driven disinflation. With the recent uptick in energy prices being factored into inflation expectations, it will be key to watch out for whether the MPC views this potential short-term rise as transitory or the beginning of a second inflation surge.

From a wider perspective, the UK economy has started to flash red, with unemployment at the highest level in almost two-years. Meanwhile, the UK housing market has been heading sharply lower, with Halifax (-4.6%) and Nationwide (-5.3%) HPI figures signalling a market that has been hard hit by rising interest rates. Finally, the latest PMI surveys have highlighted a contraction for the UK economy, with both services and manufacturing figures below the key 50 threshold. This mix of data will undoubtedly put pressure on the BoE to halt their tightening process.

UK unemployment

Who to watch?

One key factor to watch is the potential dissent within the Monetary Policy Committee (MPC). Dhingra, a traditionally dovish member, is expected to voice his preference for maintaining the Bank Rate at its current level due to concerns that policy is already too restrictive and further tightening could jeopardize economic growth. Despite this, the dissent is likely to be limited, with an expected vote split of 8-1 in favor of the 25-basis point hike, a less divided outcome compared to the August meeting.

Market sentiment has also shifted towards a more cautious stance, as influential BoE policymakers, including Governor Bailey and Chief Economist Pill, have signaled their preference for a lower terminal rate and an extended period at that level. This suggests that the market’s current pricing, which places the terminal rate just shy of 5.6%, may be overestimating the BoE’s intentions.

Outlook

In terms of official guidance, it is unlikely to deviate significantly from the previous month’s statement. The BoE is likely to reiterate that current policy is considered restrictive and that further tightening could be implemented if persistent inflationary pressures emerge. This stance aligns with that of many other G10 central banks, which are data-dependent in their approach to hiking rates. As mentioned, that data dependency could result in pressure to hike further down the line if energy prices drive another rise for UK inflation.

Aside from the rate decision, the September meeting will also include the MPC’s annual review of its quantitative tightening (QT) program. Given the smooth progress of QT and the BoE’s desire to reduce its balance sheet size quickly, an increase in the pace of QT to around £100 billion per annum should not come as a surprise. This decision may not cause significant reactions in gilts but will continue to lead to losses on the BoE’s asset portfolio due to rising rates.

Looking at the economic outlook, the MPC is expected to adopt a more cautious tone, as the growth outlook has deteriorated further since the August Monetary Policy Report. Weak consumer spending and deteriorating economic indicators, such as services PMI, point to downside risks, although the MPC may wait until November to explicitly state this, given external factors like the sluggish Chinese economy and upcoming remortgaging pressures.

In summary, the upcoming Bank of England interest rate decision is expected to bring another rate hike, but they are likely to follow the ECB’s lead of taking a largely dovish stance that would signal the likely end of this tightening phase thanks to deteriorating economic indicators. The MPC’s cautious tone on growth and inflation, along with potential dissent within the committee, may influence market sentiment and asset prices, including the pound and equities.